Trains use three times less energy than cars to transport people; six times less energy than trucks to move freight. Trains use and emit just one-fifth the amount of carbon dioxide. Governments can help fight global warming by using competition policy and tax incentives to induce transportation customers to switch to rail.

There is a general consensus that rail transportation is more energy-efficient than travel by automobile, and thus that it contributes less to pollution. On average, trains use three times less energy than cars to transport a given number of people. For moving freight, trains use six times less energy than trucks and emit just one-fifth the amount of carbon dioxide. As policymakers seek to reduce carbon emissions in order to combat global warming, they would do well to promote greater usage of rail transportation and less reliance on the highway system. Pricing systems that engender competition between different means of transport are one potentially potent way to do so.

However, some analysts are pessimistic about the viability of using economic policy instruments, such as competition policy and taxes levied upon various modes of transportation, to promote both economic and energy efficiency. For example, Germany's Monopolkommission issued a special report earlier this year1 concluding that competition within the German rail sector is substantially underdeveloped and that there is little scope for competition amongst different modes of transportation. Even if politicians have eventually pushed through the needed reforms of the German rail transport system in order to improve its efficiency, Deutsche Bahn AG, the legacy operator, would still remain the largest rail operator. Moreover, the report concluded that there is little meaningful competition between road and rail. According to the Monopolkommission, commuters accustomed to the comfort, flexibility, and unrivaled sense of freedom they enjoy as automobile drivers are unlikely to switch to rail offerings, even in the face of changing economic incentives. Thus, except in rare circumstances, trains are not in the same market as cars and trucks. Apparently, there is no substitute for the road.

Such naysayers overstate their case. Both intra-modal and inter-modal competition in transport are more effective than the pessimists suggest. While the rail sector is indeed overdue for reform, current conditions are not as disappointing as suggested, given the rail sector's characteristics and structure. More importantly, intra-modal competition need not be a panacea, as commuters are indeed willing to substitute between various modes of transportation. Inter-modal competition, guided by appropriate tax-policy instruments, can play a significant role in improving transportation outcomes for consumers, firms, and the environment.

Admittedly, there are some sectors in which inter-modal competition does not exist and therefore competition between operators is necessary. If one wishes to move thousands of tons of coal from a mine to a power plant, it is far too costly to use hundreds of tractor-trailers when a single train can do the job, provided adequate rail infrastructure exists. In such circumstances, the power-plant director would prefer to choose amongst several available rail operators, as intra-modal competition would result in a lower price. However, rail is a network industry, and there are some sector-specific characteristics that mean we shouldn't expect intra-modal competition to be as vigorous as in commodities markets.

First, economies of scale play a very important role in the rail industry: greater traffic brings lower costs. Given this technical reality, it’s not socially efficient to have many firms operating in the industry. Moreover, given access to a dense network, cost structures are such that competition can become very fierce. In effect, any increase in activity allows for a sharp decrease in costs and thus in prices. Under such circumstances, some firms go bankrupt and leave the market. In the presence of economies of scale, we should not expect a large number of firms to operate simultaneously.

Second, even when new entrants are more efficient than legacy operators, their cost advantages can quickly erode. When the market share of a rail company increases, it must also increase the frequency of its service in order to reduce passengers' waiting times. These customers, satisfied by frequent service, then make more trips, inducing the operator to further increase the frequency of service.

Third, the structure of demand also determines the degree of competition in an industry. While the occasional traveler is generally receptive to low-price offers from any given provider, more regular customers, such as business travelers, are less responsive to price competition, because, for them, changing from one provider to another entails significant switching costs.

Thus, in a network industry such as the rail sector, it is unreasonable to expect an outcome resembling perfect competition. Germany's rail services ought to be liberalised, but intra-modal competition is not a cure-all for economic development and social well-being. Fortunately, inter-modal competition is much more effective than the pessimists suggest.

Urban tolls, such as London's well-known congestion charge, are effective in reducing the use of automobiles and inducing commuters to switch to other modes of transport. All econometric studies show that it takes time for this substitution to occur. Considered from a reasonably patient perspective, there is a striking degree of substitution amongst air, rail, and road travel. One only has to think of the success of the high-speed trains between Paris and Marseille, Geneva, Brussels and London.

Obviously, such success is dependent on well-organised underlying infrastructure. This is often absent. For example, trains carry only 3% of land cargo traveling between the Iberian Peninsula and the rest of Europe, largely because Spanish rails are 1668 millimeters wide, while the European gauge norm is 1435 millimeters. Nonetheless, there remain profitable opportunities. SNCF, France's public railway operator, offers regular service between France's border with Spain and Luxembourg to move 30,000 truck’s worth of cargo over 1,000 kilometers in much less time than is required by road. Automatic gauge-switching technologies and new Spanish rail lines built at the European width will further intensify inter-modal competition in the future.

Numerous studies have concluded that inter-modal substitution is not negligible. For example, Australia's Bureau of Transport and Regional Economics maintains a Transport Elasticities Database2 of work on the subject. Travelers respond to incentives. Therefore, significantly increasing fees for using cars and trucks, through the imposition of tolls and taxes on gasoline, for example, would induce shifts of people and commodities from road to rail. More effective intra-modal competition that reduced rail prices would also attract new customers.

Contrary to the view expressed by some analysts, policymakers should not feel that transport policy is largely irrelevant in the effort to reduce greenhouse gas emissions. Price incentives and competition in the transportation market are powerful tools to promote economic and energy efficiency.